It is now evident that the Fed is flowing a policy of quantitative easing. Unfortunately, they have not been willing to be explicit in announcing there policy change. Now, some may argue that we are premature about making this announcement since the Fed funds rate is still at 1% bu the latest round of Fed announcements of buying commercial paper and MBS and GSE debt is all but stating the obvious.
This should not be surprising given that Chairman Bernnake has researched this issue extensively all the way back in 2004 in "Monetary Policy at the Zero Bound: An Empirical Assessment" with Vincent Reinhart and Brian Sack. In that important paper, Bernanke and company discusses the policy alternatives when rates start to reach zero. There are three major policy alternatives, communication, quantitative easing, and balance sheet policies. It could be argued that the Fed is engaged in all three of these alternatives right now.
First, the Fed has made clear that they will provide significant funds through a number of programs to provide the market with liquidity. They have also made clear that they are will to provide funds even if this lowers the Fed funds rate below the target.
Second, the Fed has engaged in actively increasing their balance sheet through providing lending facilities. It has provided more repo lines, the dealer lending facilities and other programs which have increased the Fed balance sheet to above $2 trillion. They have been providing funds to offset the delevering by private sources.
Three, the Fed has been willing to take on credit risk in order to provide liquidity and to affect the yield curve. The outright purchase of GSE debt and MBS is similar to earlier policies like Operation Twist to use its buying power to affect longer-term rates and rates that seem to be out of line relative to historical relationships.
The good news is that three prong attack to affect the economy is right out of their policy choices discussed in the 2004 paper. Unfortunately, the bad news is that the impact of these policies may take some time so no one should expect monetary miracles over the next few weeks. The size of the liquidity problem outstrips the impact that was modeled in the 2004 paper.
This should not be surprising given that Chairman Bernnake has researched this issue extensively all the way back in 2004 in "Monetary Policy at the Zero Bound: An Empirical Assessment" with Vincent Reinhart and Brian Sack. In that important paper, Bernanke and company discusses the policy alternatives when rates start to reach zero. There are three major policy alternatives, communication, quantitative easing, and balance sheet policies. It could be argued that the Fed is engaged in all three of these alternatives right now.
First, the Fed has made clear that they will provide significant funds through a number of programs to provide the market with liquidity. They have also made clear that they are will to provide funds even if this lowers the Fed funds rate below the target.
Second, the Fed has engaged in actively increasing their balance sheet through providing lending facilities. It has provided more repo lines, the dealer lending facilities and other programs which have increased the Fed balance sheet to above $2 trillion. They have been providing funds to offset the delevering by private sources.
Three, the Fed has been willing to take on credit risk in order to provide liquidity and to affect the yield curve. The outright purchase of GSE debt and MBS is similar to earlier policies like Operation Twist to use its buying power to affect longer-term rates and rates that seem to be out of line relative to historical relationships.
The good news is that three prong attack to affect the economy is right out of their policy choices discussed in the 2004 paper. Unfortunately, the bad news is that the impact of these policies may take some time so no one should expect monetary miracles over the next few weeks. The size of the liquidity problem outstrips the impact that was modeled in the 2004 paper.
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